Types of Mortgage Loans
Understanding Different Types of Loans
Today's
homebuyer has more financing options than have ever been available
before. From traditional mortgages to adjustable-rate and hybrid loans,
there are financing packages designed to meet the needs of virtually
anyone.
While
the different choices may seem overwhelming at first, the overall goal
is really quite simple: you want to find a loan that fits both your
current financial situation and your future plans. Though this article
discusses some of the more common loan types, you should spend time
talking with different lenders before deciding on the right loan for
your situation.
General categories of loans
Most loans fall into three major categories: fixed-rate, adjustable-rate, and hybrid loans that combine features of both.
- Fixed-rate mortgages
As
the name implies, a fixed-rate mortgage carries the same interest rate
for the life of the loan. Traditionally, fixed-rate mortgages have been
the most popular choice among homeowners, because the fixed monthly
payment is easy to plan and budget for, and can help protect against
inflation. Fixed-rate mortgages are most common in 30-year and 15-year
terms, but recently more lenders have begun offering 20-year and
40-year loans.
- Adjustable-rate mortgages (ARM)
Adjustable-rate
mortgages differ from fixed-rate mortgages in that the interest rate
and monthly payment can change over the life of the loan. This is
because the interest rate for an ARM is tied to an index (such as
Treasury Securities) that may rise or fall over time. In order to
protect against dramatic increases in the rate, ARM loans usually have
caps that limit the rate from rising above a certain amount between
adjustments (i.e. no more than 2 percent a year), as well as a ceiling
on how much the rate can go up during the life of the loan (i.e. no
more than 6 percent). With these protections and low introductory
rates, ARM loans have become the most widely accepted alternative to
fixed-rate mortgages.
- Hybrid loans
Hybrid
loans combine features of both fixed-rate and adjustable-rate
mortgages. Typically, a hybrid loan may start with a fixed-rate for a
certain length of time, and then later convert to an adjustable-rate
mortgage. However, be sure to check with your lender and find out how
much the rate may increase after the conversion, as some hybrid loans
do not have interest rate caps for the first adjustment period.
Other
hybrid loans may start with a fixed interest rate for several years,
and then later change to another (usually higher) fixed interest rate
for the remainder of the loan term. Lenders frequently charge a lower
introductory interest rate for hybrid loans vs. a traditional
fixed-rate mortgage, which makes hybrid loans attractive to homeowners
who desire the stability of a fixed-rate, but only plan to stay in
their properties for a short time.
Balloon payments
A
balloon payment refers to a loan that has a large, final payment due at
the end of the loan. For example, there are currently fixed-rate loans
which allow homeowners to make payments based on a 30-year loan, even
though the entire balance of the loan may be due (the balloon payment)
after 7 years. As with some hybrid loans, balloon loans may be
attractive to homeowners who do not plan to stay in their house more
than a short period of time.
Time as a factor in your loan choice
As
has been discussed, the length of time you plan to own a property may
have a strong influence on the type of loan you choose. For example, if
you plan to stay in a home for 10 years or longer, a traditional
fixed-rate mortgage may be your best bet. But if you plan on owning a
home for a very short period (5 years or less), then the low
introductory rate of an adjustable-rate mortgage may make the most
financial sense. In general, ARMs have the lowest introductory interest
rates, followed by hybrid loans, and then traditional fixed-rate
mortgages.
FHA and VA loans
U.S.
government loan programs such as those of the Federal Housing Authority
(FHA) and Department of Veterans Affairs (VA) are designed to promote
home ownership for people who might not otherwise be able to qualify
for a conventional loan. Both FHA and VA loans have lower qualifying
ratios than conventional loans, and often require smaller or no down
payments.
Bear
in mind, however, that FHA and VA loans are not issued by the
government; rather, the loans are made by private lenders. FHA loans
are insured to the actual lender and VA loans are guaranteed in case
the borrower defaults. Remember too, that while any U.S. citizen may
apply for a FHA loan, VA loans are only available to veterans or their
spouses and certain government employees.
Conventional loans
A
conventional loan is simply a loan offered by a traditional private
lender. They may be fixed-rate, adjustable, hybrid or other types.
While conventional loans may be harder to qualify for than
government-backed loans, they often require less paperwork and
typically do not have a maximum allowable amount.